First vs. Second Mortgages: All You Need to Know

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Mortgages are key to any real estate transaction, as most homebuyers will need one to help finance the purchase of a home or property. A first mortgage is the primary loan on the property. Later, some homebuyers may obtain a second mortgage, an additional loan alongside your primary mortgage, that uses the home as collateral.

Knowing the difference between the two is important for making informed mortgage decisions and choosing when and how to refinance. In this article, we’ll explain how second mortgages work and describe when you might opt for one.

What is a first mortgage?

A first mortgage is the primary loan that a homebuyer uses to acquire a home or property, and the loan is typically backed by the value of the property itself, or the loan-to-value (LTV) ratio. The LTV helps lenders decide if they should lend to you and if you’ll be required to pay private mortgage insurance.

A mortgage comes with terms and conditions, including an interest rate that is either fixed or variable, and the time period you have to pay your mortgage in full. First mortgages are typically issued for 15- or 30-year terms.

A key to obtaining favorable terms on any mortgage is your creditworthiness. Good credit can lead to lower down payments and better interest rates. This can be particularly important for financing expensive properties with a jumbo mortgage loan or a super jumbo loan. These loans exceed federal lending standards and, therefore, come with stricter qualifications.

Key considerations for first mortgages

Landing your first mortgage involves several steps to determine your creditworthiness and decide the terms of the actual loan. Those steps include pre-approval, the application process, and then closing on the loan.

To get pre-approval, you’ll submit financial documents to a lender who will assess your creditworthiness and provide an estimate of the loan you can get. The application will involve providing detailed information about your finances and the property, including an appraisal. When you’re ready for the closing, you’ll sign the final documents, pay the final costs, and officially take over ownership of the property.

The down payment is a crucial step toward closing the deal successfully. It’s determined by many factors, including the total loan amount, your credit, and how much debt you have. Some buyers may try to pay 20% of the home’s purchase as the down payment, as this can help avoid paying private mortgage insurance, which increases your monthly mortgage payments.

First mortgages are typically either fixed-rate or adjustable-rate mortgages, or ARMs. Fixed-rate options offer consistent and stable monthly payments and interest rates. ARMs may start with lower rates, but those can adjust periodically, which may save buyers money if rates fall over time but may also cost more if rates rise. Buyers should balance their needs for stability versus long-term savings when considering these two options.

Some homeowners may eventually consider refinancing their first mortgage and can look at mortgage refinance rates to see the financial impact of that decision.

What is a second mortgage?

The first mortgage is used to obtain the property in the first place; a second mortgage is a loan taken out against the equity on the home or property. Home equity is the difference between what your home is worth and the amount you still owe on the mortgage. Homebuyers can use second mortgages for several reasons, including funding for major expansions, necessary repairs, or debt consolidations.

However, even though second mortgages help owners leverage their home equity, they can come with higher interest rates and shorter terms depending on the state of the market and your creditworthiness. Second mortgages are also subordinate to the original mortgage, which takes priority during debt repayment.

Types of second mortgages

Second mortgages usually come in two types: home equity loans or home equity lines of credit, a.k.a. HELOCs. A home equity loan is a lump sum with fixed interest rates and set repayment terms. The loan must be paid back in a certain number of years, or the borrower will face foreclosure on the property.

HELOCs, on the other hand, offer a revolving credit line. You set up an open line of credit, similar to a credit card, and borrow money up to a predetermined limit as needed. This allows you to make multiple withdrawals, but you only pay interest on the amounts you borrow.

Both types of loans use your home’s value as collateral on the loan. Defaulting on either loan can lead to foreclosure and other financial penalties. Understanding the difference between the two will help ensure responsible borrowing situations.

When to opt for a second mortgage

Knowing when a second mortgage is the right move involves weighing several factors.

Homeowners might need money for specific uses, such as renovations, tuition costs, debt consolidation, or investments. Another factor to look at is whether a second mortgage might save money compared to other borrowing options. If the interest rate is lower than that of credit cards or personal loans, a second mortgage might be the right choice.

Whatever the reason for seeking a second mortgage, look at your long-term financial stability and goals before going forward. Borrowers should ensure they can manage the additional debt, repay the loan, and be prepared for any changes in income or expenses down the road.

Disclaimer: Article content is intended for information only. It may not reflect the publisher nor employees’ views. Consult a mortgage professional before making financial decisions. Publishers or platforms may be compensated for access to third party websites.

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